On Thursday, risk assets will welcome another positive development - the Federal Reserve stops "tapering"?
The market widely expects that the Federal Reserve will announce the cessation of the quantitative tightening (QT) process at this Thursday's FOMC meeting to address the tightening of financing markets and liquidity headwinds. This move aims to terminate the continuous outflow of bank reserves, stabilize the repurchase market, and alleviate the pressure of rising financing costs, thereby providing decisive support for the rebound of various risk assets
If the Federal Reserve decides to halt its quantitative tightening (QT) program, it could inject new momentum into the improving global liquidity backdrop and provide decisive support for risk assets.
The market is increasingly anticipating that the Federal Reserve will announce the end of its "balance sheet reduction" process at this Thursday's FOMC meeting. This expectation arises against the backdrop of key financing markets signaling tension, while recent statements from Federal Reserve officials have opened the window for a policy shift.
Federal Reserve Chairman Jerome Powell stated earlier this month that the Fed may stop reducing its balance sheet in the "coming months," and Governor Christopher Waller also acknowledged that reserves in the banking system may have reached "ample" levels. As a result, most Wall Street strategists have adjusted their expectations, believing that the central bank will pause balance sheet reduction by the end of October.
For investors, ending QT will eliminate a persistent liquidity headwind. This is expected to alleviate the monetary market pressures that have led to rising financing costs and may lay the groundwork for a rebound in various risk assets by lowering leverage costs and restoring market depth.
Saying Goodbye to QT: A Key Step to Stabilize the Market
Recent market dynamics indicate that the demand to end QT is becoming increasingly urgent. As the balances in the Federal Reserve's overnight reverse repurchase agreement (RRP) tool are depleted, an important "shock absorber" function of the financial system has been weakened, leading to rising financing costs and increased interest rate volatility.
According to strategists' analysis, repo rates have currently risen above the interest on excess reserves (IORB) and have even touched or exceeded the upper limit of the Federal Reserve's federal funds rate target range, forcing market participants to rely more on the central bank's standing repo facility (SRF). This dynamic effectively constitutes a "mechanical" tightening of financial conditions, which, even without a change in the policy interest rate by the Federal Reserve, raises leverage costs, suppresses risk appetite, and expands risk premiums across various assets.
Halting QT will directly terminate the ongoing outflow of bank reserves and signal the imminent rebuilding of systemic liquidity buffers. This "shock absorber" is crucial for maintaining the normal operation of the repo market and stabilizing short-term interest rates. As reserve levels stabilize, the system's funding elasticity will be restored, thereby reducing volatility in the repo market and the risk of a repeat of the funding stress seen in 2019.
Once general collateral repo rates fall back within the Federal Reserve's target range, it will help lower rollover costs, restart relative value trading, and allow traders to regain their willingness to take on risk. This is a prerequisite for narrowing spreads, deepening liquidity, and reducing volatility in the credit, equity, and interest rate markets.
Reshaping Policy Signals and Market Confidence
Ending QT will also send a clear signal to the market: the Federal Reserve currently prioritizes maintaining policy control and market stability over further reducing its balance sheet.
This move is equally significant for the U.S. Treasury market. As noted by researchers at the Minneapolis Federal Reserve, the current system has become "rich in collateral but poor in cash." Ending QT will help alleviate the pressure of collateral excess, allowing existing reserves to finance the market more effectively, thereby improving market depth and reducing reliance on the Federal Reserve as a lender of last resort A more stable U.S. financing environment will generate widespread spillover effects. It will help alleviate the dollar scarcity issue, ease global financial conditions, and support a broad recovery in cross-asset risk appetite. According to Bloomberg strategist Simon White's analysis, given that the excess liquidity in the Group of Ten (G10) is turning downward, the Federal Reserve's support will be particularly timely.
More importantly, if the Federal Reserve decides to support domestic liquidity, it will resonate with the strong upward momentum of China's M1 money supply growth and fiscal transmission. This scenario will create a synchronized liquidity foundation driven by the world's two largest economies, supporting risk assets and dampening market volatility
